The Costs and Distributional Effects of Unemployment

The classical view on unemployment says that there are only unemployed people who are not able and willing to work at the going wage rate. So if people would accept a lower wage they would find jobs. In this view all unemployment is a short-term problem and the best solution is laissez faire – leave the market to find equilibrium to resolve the issue of unemployment.

If people accept lower wages then the costs of living will fall as firms do not need to charge such high prices, so in fact workers will find the lower wages are acceptable once they start work. This view on unemployment is known as the real wage unemployment. People who believe this is the only cause of unemployment think that out-of work benefits should be cut, trade unions should be curtailed and there should not be a minimum wage.

The opposing, Keynesian view, is that people can be unemployed even in the long run. This is because there is insufficient aggregate demand in the economy. If you believe that the economy can be in equilibrium but not everyone has a job then there is demand deficient unemployment or cyclical unemployment. Keynes said that if people do not spend, then there will be fewer job opportunities. If people are losing jobs then there will be even less spending and the vicious cycle continues. Even if wages are cut there will not be more people employed – lower wages will mean that there is even less spending so even fewer people are needed in employment.

Another theory for employment problems that aren’t linked solely to labour being unwilling to work at the going rate is that the economy is undergoing structural change and therefore different types of labour are required. Over time due to re-training these structural unemployment problems will disappear.
There are many different costs associated with unemployment that affect different people. There are the obvious costs to the individual who will have lower incomes and so their living standards will fall. However they also lose morale and their skills set can become obsolete. There are also costs to firms who will discover that people will spend less if there is high unemployment and so will have to lower prices and make less of a profit. There is also the cost to the government who will receive less in tax and will have to pay more in various benefits.